Commentary
How munis have fared under the new tax law

The municipal market continues to go about its business in classic fashion. Although the pace is quite a bit less hectic than the level of activity in December, the market continues to price and distribute bonds in due fashion. We have recovered somewhat collectively from the dark and disturbing threat that Private Activity Bonds (PABS) could have been taken away from us. What has been lost, namely the ability to do an Advance Refunding, is quite unlikely to be regained despite various efforts afoot. Alas, there is the rub.

John Hallacy
Doug Goodman

Many rogues, scoundrels and miscreants would count us out and will continue to challenge our turf. Many believe as do I that as the federal deficits mount, PABs will probably be on the table once again. How do we reconcile this tendency with the proposal to expand PABs in the administration’s infrastructure plan? It is one of the great mysteries of 2018 that may be revealed in time.

Volume in the first quarter has plummeted from the first quarter of last year as has been broadly anticipated. The first quarter issuance logs in at $61,356.1 billion versus $92,273.4 billion a year earlier. On the other hand, the number of issues coming to market has been fairly robust at 1,692. A plethora of smaller transactions has been interrupted on occasion by some very large transactions, such as the California general obligation offering at $2.1B.

Others will parse the numbers in more detail than I will do here. However, it is toilsome to ignore that taxable municipal issuance is on the rise. The taxable volume of $4.6 billion is approximately 7.5% of total municipal volume. More noteworthy is that the number of taxable issues at 165 was a full 10.3% of the municipal market. We have had more anecdotal evidence that financing teams are examining harder whether it makes good economic sense to consider doing taxable refundings. In a rising rate environment, this trend may encounter turbulence; however, we do expect some more activity ahead. Certain sectors have been willing to embrace taxable issuance for some time now. The Higher Education and Health Care sectors are prime examples.

Credit challenges are also ever present but, thankfully, the proportion of troubled credits is relatively minor. Defaults are at recent lows. However, I believe that many credits are experiencing various levels of budget and financial stress. When a budget gap is 2% to 3%, one time actions may swiftly close such a gap level. When the gap is in the 5% to 10% range, taking measures to close the imbalance take many more deliberate actions. When a gap is over 10%, there is trouble in river city.

The recent steps taken by the state of Connecticut to ensure that bond payments of its capital city will be made is most reassuring. We applaud the action. The only lingering concerns are whether the real reforms that will be required to attain balance over a number of years will be forceful enough and whether the measures will be fully implemented. The bond insurers’ presence will be most helpful in this regard.

Lingering concerns about the willingness to pay in the general obligation segment of the market have propelled fund managers and others to favor revenue bonds. Fortunately for them, revenue bonds still represent about two-thirds of the volume coming to market. Despite the decline in issuance, bond selection may still be gauged as abundant.

However, concerns have been raised in certain legal quarters about the efficacy of the pledge and first lien on revenues. The basic creditworthiness of the issuance is a bulwark against this fear becoming a reality. Yet, the mere questioning of these widely held tenets is troublesome at best.

The redeeming fact of this market at present is that given the supply status many potential market nuances are lost in the mix. Some states are badly hurting for supply and as soon as an offering of any significant size and scope is offered, said transaction is swiftly put away by dealers. Even in states where supply has been ample the market tone is strong.

Municipal rates continue to track the Treasury market but not in lock step. Supply dips have helped the market tone. The Bond Buyer Revenue Bond Index is up 45 basis points since the beginning of the year as of this writing. Rates are still considered quite manageable despite this fact. More importantly, on a ratio basis, the levels remain quite favorable. The latter will probably be affected by the technical aspects of the market going forward. Treasury issuance is on the rise due to the inevitable increasing federal deficit. Tax Reform and additional spending in the federal budget have assured this development. Continuing economic expansion would be expected to provide some relief in this regard but most are resigned to the fact that such activity won’t be enough to offset significant amounts of the federal deficit.

We are looking forward to the seasonal increase in long term new money supply in the second quarter. High yield investors and accounts have been lamenting the lack of supply in the segment. Many of the managers have even had to allow that they have been investing in investment grade due to the woeful level of high yield supply. Their lamentations are about to be answered to a degree. The mega sized tobacco sector refundings are on the way. The only challenge here is that taxable municipal investors and accounts will benefit. If high yield issuers are contemplating coming to market, we respectfully submit that the time is ripe.

The volatility in the equity markets has financial advisors weighing more investments in municipals for their clients. In years of yore, one had to take discussions of “the great rotation” very seriously. Asset allocators especially on the retail side will be carefully considering the implications this year. Given this anticipated behavior, we believe that municipals will come out on the winning side.